Monday, September 29, 2008
The Economy
While this post is not directly related to either of the two presidential candidates, I think it is still a valid point of discussion. This is an editorial from a professor of economics at Harvard. Professor Miron obviously subscribes to the theory that the economy will take care of itself, if the government will just butt out. While I typically subscribe to the opposing theory, he does make some pretty compelling arguments. Anyone have any opinions about what he says?
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Prof. Miron says the current financial crisis is the result of 1) Fannie and Freddie and 2) the Community Reinvestment Act. Paul Krugman (I'll see your Harvard Prof. and raise a Princeton one), among others points out that Fannie and Freddie actually only played a minor role in the sub-prime lending mess; the majority of the bad loans were made by private loan originators. To the point about the CRA, it's a bill that was passed in 1977 to encourage depository institutions to lend more to members of their community who need it; you can see how easy it would be to blame the sub-prime mess on it. However, 1) if the bill was passed in '77, why's it taken so long for it to cause a problem?, 2) the Federal Reserve website points out that the law does not "require institutions to make high-risk loans that jeopardize their safety. To the contrary, the law makes it clear that an institution's CRA activities should be undertaken in a safe and sound manner." Easier said than done, I'll admit, however that leads me to 3) many argue (I think rightly so) that profit was much more of a motivating factor behind institutions making these loans than their desire to comply with Federal Regulations. And that leads me to my next point.
Miron's argument is sort of true, but it also misses the major point that sub-prime lending would never have turned into this giant mess if it weren't for the way those sub-prime loans were bundled into mortgage-backed securities. The fact that the institutions making the loans could then immediately turn around and sell them to Wall Street firms, absolving them of most of their responsibility, only gave further incentive to make bad loans. The Wall Street firms were only willing to buy them because they could then bundle them up and then sell off shares of the bundled loans (a.k.a mortgage-backed securities) to investors. Investors were only willing to buy the securities because Moody's was giving them a high rating, indicating that they were "safe" investments when, in fact, they weren't. My point is that there are a lot of factors that have gone into this mess--most of them leading back to profit, which also happens to be the leading force behind that tricky "invisible hand."
Anyway, all that's mostly just trying to make Miron look bad, and I hate it when politicians do that. The important thing we should be looking at is Miron's argument that bankrupt companies aren't all that bad. He's right that bankrupt companies don't necessarily mean non-existent companies. But what he doesn't point out is that they almost always mean people losing their jobs. Here's another article on CNN that talks about the difficulties many bankers are having finding jobs after their firms have gone under. Do I feel bad for them? Well, sort of, but not really. However, if we let more banks go under, that's more people losing their jobs. If enough people lose their jobs, that's gonna start hurting those of us who haven't sold our souls to the investment banks (my apologies to my i-banker friends, I didn't mean it). Once enough people start losing their jobs...well, let's just say I don't like how that starts to look. Miron also uses the argument that several airlines have gone bankrupt and the planes are still flying, but I think we all know how much flying can suck now--that's due in large part because airlines are struggling so much to get out of bankruptcy. Like paying to check more than one bag? Me neither. Know what else I don't like? All the negative numbers on my 401(k) statement.
Anyway, that's an entirely too long-winded way of saying I wish we didn't have to pony up $700 billion to try to fix this mess. I'm not 100% confident it will fix the mess, but the alternative is too scary for me. Besides, you can't sell sub-prime loans unless there's someone on the other end who'll buy them, even when they know (or should) that they can't afford it. Who bought them? Taxpayers. Maybe we should foot at least some of the bill.
So...kind of both parties agree on the bailout, right? I mean it seems that both Obama and McCain are supporting a bailout and from what I've heard on the news (unless I am misunderstanding...which is totally possible) that seems to be the consensus of the 'experts' the media talks to.
I know that the bill didn't pass yesterday though. And while it seems both parties agree that it's a good idea I have read so many blogs where people are very angry about having to pay for corporate America's mistakes and how they were greedy, money-hungry, etc. and they don't really care if they go down.
And so what you are saying, if I am understanding, is that if they don't get bailed-out then things will continually spiral downward and companies will go under, hundreds (thousands?) will lose jobs and we will not just be in a recession, but more like a depression?
Maybe people don't really understand what they are asking for when they say they are anti-bailout. I have read the anti sentiment on both republican and democrat blogs.
If I were McCain or Obama I would definitely want a good start on this clean-up though before I took office and had to deal with all of the other things I promised to fix in the country.
You're absolutely right. Both candidates essentially said they would have voted for the plan and Democrats and Republicans in the Senate were pretty much unified in their support. However, the main reason the bill failed is because of the number of Republicans in the House that voted against it (but 95 Democrats voted against it, too). You're also right that while "experts" and the media are largely for the bill, public sentiment is largely against it, and I think that is because our leaders haven't done a good job of explaining how bad things could get if we don't do something. Then again, maybe they don't know either. It's a tricky situation. On the one hand, the limited business and economic knowledge I do have tells me this is serious and we could be in a lot of trouble if we don't do something soon. On the other hand, since no one's talking in specifics about how bad it would really be, we pretty much have to take their word for it--something I think a lot of us are not too comfortable doing anymore with Bush and crew.
Anyway, the negative public sentiment is particularly a problem right now because a lot of politicians are up for re-election in November. In fact, they said on CNN last night that the majority of the people (Republicans and Democrats) who voted against the bill are in tight races for re-election. So much for "putting politics aside for the good of the country" I guess.
I'd like to weigh in on Hebe's original question about Miron's editorial.
Miron makes a sweeping accusation that "Congress pushed mortgage lenders to expand subprime lending." I'd like to see what evidence he has for suggesting that. Does anyone have more information on what that accusation is based on? As Jed suggested, I've found a lot more evidence to suggest that the blame lies with private industry acting with inadequate government oversight: banks engaging in predatory lending, offering loans to people that weren't credit worthy and not doing due diligence to determine whether they could afford the loans, credit rating agencies giving prime ratings to mortgage backed securities, suggesting they were a lot safer than they really were. In short, I think Miron's grasping at straws trying to blame the mess on government intervention, rather than on a lack of regulatory oversight.
I agree with many of Miron's other points, though. First, he basically argues that bankruptcy isn't such a bad thing. I generally agree. The free-market principle that allows companies to fail makes for a more competitive, survival-of-the-fittest economy. Capital and resources shift from inefficient business to efficient ones.
But although I generally agree with that view, I disagree that we should let a lot of financial institutions fail during a widespread financial crisis. The thing is, financial institutions are like the circulatory system of our economy, moving money around between between the parts that make the system work. If money stops flowing through the economy, like a patient whose heart stops beating, the economy tanks, unemployment spikes, and it takes a long time to resuscitate it. That government-hands-off, stick-to-your-free-market-guns approach is how the government reacted to the market crash of 1929, leading to the great depression. Paul Krugman's The Return of Depression Economics, published in 2000, is an insightful thesis on the role governments should play during financial crises, including when it's appropriate to surrender lassez-faire principles to avert a disaster.
Furthermore, because of the interdepencies of these large financial institutions, the failure of one or two leads to a chain reaction that takes down many more. The Wall Street Journal concluded that Paulson's decision to let Lehman Brothers fail led to the crisis that took down AIG, Morgan Stanley, and Goldman Sachs (and now Wachovia).
I strongly agree with Miron's statement that the precedent that a bailout sets would encourage companies "to take large, imprudent risks and count on getting bailed out by government." That is precisely why once this crisis is averted, we need to get back to intelligent, effective regulatory oversight. If the government is going to be on the hook when things go bad, it has the right to make sure banks are being prudent when times are good. We can't risk the next great depression just to teach a few CEOs a lesson. But we do have to put practices in place to make sure we don't get our hands tied again. I like the analogy Obama used: When you're neighbor's house is on fire, you don't stop to lecture him about how he shouldn't have been smoking in bed. You first put out the fire to make sure it doesn't spread to your own home. There'll be time enough for lectures and better safety measures afterwards.
Finally, I also agree with Miron's statement that "bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents." That's what was so bad about Paulson's original plan: it would only help if the government overpaid for lousy assets. That's why buying up bad debt is a bad use of taxpayer money. A better, more proven approach would be for taxpayers to get an equity stake in these companies. That would improve the companies balance sheets and stem the runs on these banks that is causing the current credit squeeze.
In conclusion, while I agree generally with a lot of what Miron says, I think he takes it too far. But I could be wrong: he might be right that talk of Armageddon is overblown. But the risk that he's wrong, and the cost of doing nothing if he is, are far too great for me to accept that we should take that chance.
Alex makes a lot of good points, especially the one about our financial institutions being like the circulatory system of our economy. I think that could be the answer to turning around the negative public sentiment of people who don't want this bill, think it's unfair to bail out Wall Street, and don't see how a failing Wall Street will affect them. I agree that it's a tricky connection to make. This op-ed piece in today's New York Times does a pretty good job of explaining how failing financial institutions would affect each of us. If you don't want to read the whole thing, read the paragraph that starts with "Well, you say, 'I don't own any stocks...'"
Still, I also agree with Alex that, while the expert doom-and-gloom opinions coupled with the economic knowledge I do have, seem to suggest we need this bailout, ultimately there's really no way to be sure. All the Armageddon talk could be overblown. Look at the Dow. Down over 700 points on the day the bill failed, but up over 400 points yesterday. That mean the markets are just "looking forward to the bill passing," just a market correction, or something else? I don't know.
Thanks for bringing up that op-ed piece in the Times by Friedman, I was relieved to see it this morning. This is a concept that the media seems to be leaving out: as we bail out Wall Street we are bailing out ourselves. No matter what our profession, or station in life, we are all touched by what happens in the market. And, many “main street” Americans bought homes they couldn’t afford, not that assigning blame does any good in the short term.
Another thing underemphasized by the media is the details of this proposed bill. We may not even use all $700 billion. Only a portion is available immediately, and any additional must be approved by congress. Plus, many of the mortgages that the government will own will be paid back. The terms of the bill also allow the taxpayers to benefit from the future gains of the companies being bailed out through shares or warrants.
Lastly, the short-term solution will have to give Paulson and Bernanke a great deal of autonomy. Congress was not designed to act quickly, it was designed to be a thoughtful, deliberative body to prevent rash decisions and mob mentality. Plus, in congress politics tends to trump economics. As soon as they got involved they were clamoring to “fix” executive pay, as if that had anything to do with the problems we face. First, even though they make a lot of money, executive salaries are a drop in the bucket compared to the market capitalizations of these companies. Second, there is a market for bank CEOs, and in it there are a few huge banks and even less people qualified to run them. Demand for talent far exceeds supply, so even if you mess up and run a bank into the ground, you still have more experience running a huge bank than most other people. Nice work if you can get it.
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